Thursday, December 26, 2013

Silver Rattles

We were asked by a friend in the media for one prediction for 2014 and a brief explanation of our position.  

Silver rallies 50% as inflation expectations rise and worldwide growth reaccelerates. 

We have used the Nasdaq bust in 2000 as a comparative guide for silver and the precious metals complex over the past three years. From a momentum and performance point-of-view, silver found a cycle low this past summer. From a relative performance perspective, silver has been outperforming gold since late July. This impressions us to believe the low inflation backdrop is shifting discretely beneath the markets as gold and silver have tested the panic lows from early summer and look poised for reversal into 2014. 

As obituaries are now being freshly penned for the precious metals sector, we pause at the timing - considering that trade had died more than two years before. On the contrary, we believe a new birth announcement is in order. 

Friday, December 20, 2013

BarKeeper's Friend

He came, he saw - he tapered. 

In a fitting bookend to his storied command of the world's largest and most powerful central bank, Bernanke trimmed our cocktail punch to the tune of $10 billion proof per month. The worlds greatest barkeeper will take us down easy.  

The impact to the market? 

We think it's appropriate to let the dust settle before making any real adjustments to our respective postures. All things considered, any taper was a welcomed signpost along the road and one we have expected. The most important thing - regardless of size, was the signal was made to the market. 

Since the Fed aborted the September taper, we have been waiting for long-term yields to turn down. Historically speaking, one could argue that the move higher in yields in the10-year note has become as stretched as it has ever been over the past 50 years. If the Fed had tapered three months back, these pressures would have very likely relieved themselves by now.    
We believe yields are going through a retest of their September highs. Although it's not a perfect comparison - it's the thought that counts these days, with respect to our more esoteric policies and their impact to participants downstream expectations. 
What has historically happened when the market digests the Fed's move away from extraordinary measures? Yields come in, the bond market does well relative to equities and precious metals outperform. Even if QE is slowly phased-out as the Fed has decreed, it appears reasonable to believe that similar dynamics will develop sooner rather than later - considering how historically stretched the markets are today.
Gold and inflation expectations have been negatively impacted from several different sides over the past few months. A weakened yen, disinflation on our shores and deflationary concerns in China and abroad - to name just a few.  With a surging interest rate environment that has yet to subside, real rates have risen. The US dollar, typically the vampire slayer of secular trends in precious metals, has not played a significant role over the past year in the precious metals sector - rates have.

From a historical perspective, the correction in gold relative to yields is at an extreme commensurate with significant lows in gold. All bets are off if real rates continue to rise, but with the taper now written in the ledger and growth starting to reaccelerate here and abroad - inflation expectations should begin to turn up, perhaps quite considerably. Considering how stretched yields have become, the angle of incidence should equal the angle of reflection.  
Some might be surprised to find that in a week which saw such pronounced weakness in gold - the silver:gold ratio was actually materially higher. We have favored silver relative to gold since this summer and believe that the current market has some similarities in this respect to the 76' low in which silver bottomed several months before gold and where the silver:gold ratio was rising. 
Once the dust settles from the taper, we will be looking for inflation expectations to reaccelerate. Concerns with our reflationary thesis would be heightened if the silver:gold ratio once again broke down. For now it continues to follow the script from our cycle comparative with the historic Nasdaq market.  
A quick look around the horn:

In light of the Fed's actions this week, we believe that Santa may have come early this year. Although seasonality strongly favors equities throughout the end of the year, a broadening top formation - similar and mirrored to how QE3 commenced has been developing over the past several weeks. 

Our 95' comparative performance profile has been an excellent guide for us throughout the year. Although we do not expect the market to break below long-term support (currently ~ 1596), our suspicions are the performance profiles will begin diverging early in 2014.
The Shanghai Composite Index had a poor performance this past week. Further concerns with their interbank market kept significant pressures on China's equity markets. Although we are closely watching China as a key component and proxy for our reflationary thesis, we don't expect to be eating any humble pie, served a la Krugman - anytime soon. 
Officials in Japan succeeded at jawboning the yen lower with promises of further stimulus. Having said that, it's influence on Japan's equity indexes - specifically the Topix and corresponding ETF - EWJ - have been marginal.  
Not surprisingly, the bloom came off Apple this past week. Similar to the previous stairs it has climbed since making a spring low, a consolidation of recent gains was to be expected.   
Wishing everyone a very Happy Holidays and a safe and healthy New Year. 

Cheers - and Stay Frosty. 

Tuesday, December 17, 2013

the Third Choir

Despite what the academics and semantics present, we remain firmly in the tapering is tightening camp. Furthermore, while it's not an apples-to-apples structural comparison (because of ZIRP and QE) to previous Fed cycles, we would argue that the esoteric nature of our current monetary policies introduces a greater behavioral catalyst for the markets to react, interpret and digest; thus, a longer lag-time between what the Fed implies and eventually does. Are they still exceptionally accommodative? You bet, but they've been trying to prepare the markets throughout the year that we are approaching a major pivot. In terms of where the rubber meets the road in the market, the bond boys voted unanimously this spring that even a mention and discussion by the Fed of the taper was equivalent to tightening these days. 

With the Chairman on deck tomorrow, we feel it's a toss-up between a ceremonial introduction of a taper or a more definitive timetable to when the Fed will begin curtailing QE. From our perspective, it's mostly a moot point - because we feel the bond market has already accomplished the lion's share of heavy lifting with higher yields through this spring and summer. 

With respect to the US dollar, we continue to expect the USDX to make another push lower towards the bottom of its long-term range. At the end of the Fed's previous accommodative cycles (1977, 1994 and 2004) - the dollar has initially come under pressure and tested the bottom of the range. Our comparative profiles of the USDX have been pointing that way since June. 
The one constant you can depend on is that participants will overreact when the US dollar weakens. Point being, they egregiously misread the tea-leaves to indicate hyperinflation on the horizon with the two most recent occasions (08' & 11') when the dollar tested the lower limits of the range. With the quantitative reservoir now almost full and reaching the Fed's flood gates - we expect to hear a very loud and boisterous third choir should the dollar double back around. 

Last year at this time we had looked at the 1980 top in gold as a prospective guide for both the current market and the US dollar. Gold did loosely follow those historic break-lines well into the spring, but a notable negative divergence was recognized in the dollar which led us to temper our downside expectations with precious metals in June and pivot bearish on the US dollar. While gold has made a round trip back towards its June lows, we feel it's only a matter of time before the market is inspired to its feet by members of the third choir and hymns from 1977.


Friday, December 13, 2013

Twelve Days till Christmas...

a Market- picker's market

A theme that we have commented on (see Here) over the past year has been a loosening of the tight correlation environment throughout the system. Markets that once galloped in unison have continued to walk with greater directional independence of their previous asset and intermarket relationships. From a long-term perspective this is a welcomed shift by market professionals and certainly considered more bullish than bearish.

Having said that, if you've listened or read the financial news over the past decade you've likely often heard the wincing market adage, "It's a stock-picker's market". And although we would tend to agree with them more often these days, from a macro perspective it's actually become a market-pickers market.

The bottom line is we still don't like Japan here, despite our more bullish leanings in other parts of the world. 

Click to enlarge images

Wednesday, December 11, 2013

Play Ball!

A wise and bearded man once said, "Everything in moderation. Nothing in excess." And although he didn't apply those words to his own considerable plantations of hair, his 2500 year-old philosophies still point us with great pragmatic purpose towards finding the mean between the extremes.

The same should be true with monetary policy.            

From eating to exercise and penicillin to parasites - we recognize that there's a time, place and dose for just about everything. Considering these extraordinary measures have been in place throughout an entire Fed cycle, it appears lost on most the reality of what QE stands for and inspires in the market these days. As the inflation data (which mind you is shown in the markets rearview mirror) slides towards the deflationary side of the continuum - many economists and participants are asking themselves, how can the Fed step away from these monetary measures when the inflation data continues to come in so weak? Why isn't the patient responding, QE was inflationary - right? 

From our perspective, the Where's Inflation?/QE conundrum (not to be confused, although entirely related and reminiscent of Greenspan's own bond market conundrum from the previous Fed cycle), doesn't require intimate knowledge of the structural transmission mechanisms of QE from the Fed to the market. At this point we'd argue it's predominantly best understood as a behavioral tool, and would guess that most are reading those respective tea leaves - backwards.

In November 2008, QE was introduced as a critically needed and positive structural development in the colossal mortgage backed securities market. These markets had stop functioning normally in the wake of Lehman and pressures were still building within the system. The bottom line became that the Fed needed to supplement the Treasury's own safety net with TARP and provide the markets more time and greater relief. One could argue that the initial behavioral effects of QE on participants was less positive than its structural intentions. They still needed to come to terms with the gravity and scope of the situation - and the Fed's extraordinary measures likely reinforced those fears and anxieties for a spell. On the one hand, participants knew the Fed was stepping in as THE backstop for the team - on the other, they realized their own catchers and players were severely injured and more hard pitches would be thrown. The bigger question at the time was - could the game still proceed and would they be able to perform?

By March 2009, participants had ample time to digest the enormous challenges, changes and dislocations that had cascaded throughout the markets for much of 2008. Although the markets were still under pressure, the banking sector was in the process of being recapitalized and the fires - while still smoldering, were no longer seen as life threatening to the system. Participants were wounded, weaker and playing from a diminutive position - but they were still there playing the game. When the Fed announced on March 18th that they were significantly expanding the size of their QE programs, it was welcomed from both a structural and psychological point-of-view. The S&P immediately surged three precent higher and most markets (sans the financials) were now trading above their 2008 crisis lows. QE had provided both a positive structural and behavioral response that helped inspired inflation expectations away from the crisis lows. 

Fast forward to today and its readily apparent the markets have moved 180 degrees away from how they first responded to QE in November 2008 and March 2009. Structurally speaking, the markets have provided corporations with an enormously beneficial window to build their historic cash positions and the individual considerable time to de-leverage from where they were just five years back. At this point it seems logical to consider that if the Fed wants higher inflation, there's significant potential energy there just lying in wait. From a behavioral perspective, the Fed's own monetary measures are no longer considered a positive stimulus for inflation expectations and growth, rather much the opposite - a confirmation that they believe the markets still require further external support. This is why we believe that the extension or curtailment of QE is predominantly a behavioral signal to the market these days - and one that participants have had plenty of time to digest since the taper was first brought to the table earlier in the year. We don't believe it's coincidental that those assets most closely tied to inflation expectations have continued to come under pressure from the relative ambiguity extended in recent months from the Government shutdown to the economic data and finally the Fed's own disparate collective consciousness. 

For those that consider this monetary experiment derivative of Japan in the previous decades or our own Great Depression in the 1930's - the taper should provide a good litmus test of whether the inflation potential previously mentioned will just lie dormant as it did in Japan - or begin seeping/surging into the economy. Broadly speaking, we feel the U.S economy and consumer is a radically different behavioral organism and more dynamic than Japan and their many entrenched doctrines. For better and worst - creativity, gluttony and ignorance has been our bliss. By Bernanke's own admission a few weeks back, in hindsight the financial crisis was quite similar to the 1907 panic, than perhaps what his entire body of academic work biased him towards with monetary policy - the Great Depression. 

While the structural and behavioral responses by participants are worlds apart today, the respective sectors most influenced by inflation expectations - or lack thereof (i.e commodities, commodity currencies, TIPS and emerging markets), have followed a similar disinflationary trend. As we mentioned a few weeks back, the difference this time around has been that the equity markets (EEM) that are predominantly derived from the commodity story have led the currency and commodities sectors themselves. 

Our general impression and as signaled by gold and silver's sprite reaction following the strong jobs report last week, is that should the Fed more definitively define a timetable of the taper, those assets most closely tied to rising inflation expectations should once again begin to strongly outperform.

At this point, and for all of our comparative perspectives - we don't believe either the Japan circa 1997 or the Great Depression parallels will hold many insights with today. A larger question once again arises: Will the game still proceed without QE and will we be able to perform? 

We still believe in the game and think Bernanke and Yellen will confirm as much. 

Monday, December 9, 2013

The bigGER picture

To round things out a bit, we decided to take a Felix Baumgartner peak at the long-term equity market cycle. Secular lows were determined and normalized by performance (SPX) and the momentum lows as expressed by the cycles respective RSI and stochastic oscillators. Because this was such a long-term study, we utilized a quarterly scale for this big-ger picture view. 

Based on these criteria, the secular lows were determined as: Q2 1932, Q3 1974 and Q1 2009.

From a performance perspective, both of the long-term cycles (32'-73' and 74'-07') delivered similar returns (~ 2600% & ~2300%) - granted the former was approximately eight years longer. From a qualitative perspective, one could argue the 32'-73' secular bull actually delivered much smoother and superior returns, compared to the latter cycle that included the collateral damages of the Tech-Bubble bursting. 

Click to enlarge images

Should the current market follow in the performance cadence of the 1980 breakout, the market is likely close to making an interim high - before retesting the previous resistance levels from earlier in the year. 
To reconcile this perspective with long-term support which currently sits ~ 1600, a consolidating range for 2014 above the Meridian would present participants with a frustrating environment for both bulls and bears alike. Food for thought.  
*  All stock chart data originally sourced and courtesy of 
*  Subsequent overlays and renderings completed by Market Anthropology